Venture Capital: A Complete Guide for Startup Investors

Venture capital (VC) has pretty much been the buzzword over the last couple of decades. The companies we know and love, WhatsApp, Facebook, and Uber, are all VC-funded. Innovation and modernization have been two of the biggest influences in a capitalistic society, and in the last twenty years or so, entrepreneurs have had the financial backing of venture capital firms to help fund their dreams. The biggest venture capital companies pick the biggest and the most profitable ideas to fund entrepreneurs out of their piggy bank – their venture capital fund. What banks traditionally thought of as risky – i.e loaning money to start-ups, is now heavily encouraged by venture capital firms. Venture capital bridges the gap between ideas and reality by providing startup funding. Let this guide be your Bible to know all things VC and most of all, find the answer to the question that has forever eluded you; ‘Is this for me?’

What is Startup Venture Capital?

Breaking It Down

Venture capital is a type of private equity where investors provide startup funding with the expectation of having long-term growth potential. Simply put, a venture capitalist invests in the company for a stake in the business it’s investing in. Venture capital companies, however, do not always need to make use of their venture capital fund, it can also be in the form of managerial expertise and technical skill. Some of the most well-known VCs are:

1. John Doerr: Some of the recognized companies in his investment portfolios consist of Amazon and Google.
2. Douglas Leone:  His famous investments are Aruba and ServiceNow.
3. Yuri Milner: His distinguished investments include Facebook, Flipkart, and Twitter

Features of Venture Capital Investments

Before you make it your mission to seek a venture capital investment for your business venture, it’s vital to understand what venture capital firms look for and how they operate. The deeper you go into how their process works, and how might an angel investor or venture partner function, the sooner you can make an informed decision on how to go about securing startup investing opportunities. A few notable differences between an angel investor and a venture fund looking for a VC investment are:

• An angel investor is a high-net-worth individual who invests his own money in startup investing. Venture capitalist investors are individuals, companies, or firms that invest from a pooled fund also known as a venture fund, from different investors in a well-established and emerging business venture.
• Angel Investors tend to be risk-averse while VCs are risk-taking in their venture capital investment options.
• Because of the level of risk, an angel investor may be reluctant to participate in business decisions while a venture partner may be actively involved to protect their VC investment.

Now, onto the features:

• Lots of Risks: Investing in highly-volatile firms is a risky startup investing plan. The business environment is very dynamic and that does not help with a business’s certainty.
• Lack of liquidity: Since huge sums of money are tied up right at the start of the investment, and dividends are hardly paid out by growth companies, it is difficult to be cash-rich.
• Long-term game: Venture capitalists look to stay for the long term especially because businesses take time to grow and for their investment to increase in value
• Innovation: As mentioned earlier, VCs look for innovation and invention in the appeal of dominating new markets.
• Equity Participation And Capital Gains – VCs invest in an equity stake in the business which can be redeemed once sold at a later time. Their hope is to sell it for a much higher price than they paid for the stake. Meanwhile, they also hold voting rights in the firm.
• Determined Exit – Venture Capitalists have a very clear game plan right from the start. They know when they want to leave and have a fixed selling price in mind to make a substantial capital gain.

Early-Stage Financing

Know What You’re Signing Up For

Setting up startup finance can get tricky. While early-stage financing is critical, most owners are sceptical and want to know if they’re getting the best deal. The worst possible nightmare for any early-stage startup is for the owners to lose control and pay for the mistakes they made while arranging for their startup capital. This is why it’s indispensable to get into the nitty-gritty of it all before you sign on anything.

• Know Your Optimal Capital Structure:

Your capital structure is the mix of debt and equity that your early-stage startup uses to finance its overall operations and growth. In your early stage financing, having too much debt can be seen as ‘debt reliant’ and as having a ‘high leverage ratio.’ Whereas, too much equity over debt means that the firm has a ‘low leverage ratio,’ but is seen as risky. The types of debt and equity are:

• Short-term Loans
• Long-term Loans
• Common Equity
• Preferred Equity
• Know Your Value – Pricing Rounds
• A priced round is an equity-based investment round that has a pre-defined valuation. Meaning, before the venture investment, the asset has a valuation and, thus, a price-per-share. In early start-up funding stages, priced rounds are the most common.
• Deferring Value – Keeping Your Equity with You:

When a business venture does not want to give away equity at the time of early-stage financing, acquiring startup capital via SAFEs or convertible notes is another option:

• SAFE or Simple Agreement for Future Equity – It’s a convertible instrument that converts into equity at a later time in the future; usually at the company’s next equity financing round or liquidation. They aren’t the same as convertible notes since it’s not debt

instrument and therefore, doesn’t have an interest rate charged on them nor does it

have a maturity date.

• Convertible notes are debt securities that convert into preferred equity after the next financing event. The convertible notes convert into the same succession of preferred stock. Both SAFE and Convertible Notes often have a valuation cap and a valuation discount, in startup funding stages for investors to protect their venture investment.

The Process of Getting VC Funding

 Your To-Do List

For you to get funding for startups can be hard but let’s assume that you’re swayed to go this route of startup finance for your business venture. It’s critical knowing your plan right from the start at all stages of venture capital because your capital funds should never be too debt-reliant or equity-reliant. To find the right mix, all entrepreneurs must show venture capital investors that they have found the right ratio of debt and equity options to secure private equity funds for capital financing. To get funding for startups, the stages of venture capital are as follows:

• The pre-seed stage.
• The seed stage.
• The Series A stage.
• The Series B stage.
• The expansion stage (Series C and beyond)
• The mezzanine stage.
• Going public — the IPO.

So without further ado, let’s discuss your step-by-step game plan to secure your investment capital:

• What’s Your Business Value?

Don’t overestimate, but don’t underestimate either. Although valuation is almost always out of your control during this type of capital financing, do your homework and use a professional appraiser if needed. Three ways to determine your business venture’s worth for your investment capital are:

1. Net asset valuation: Add the assets on your balance sheet and subtract any long-term debt. This method of securing private equity funds, however, does not consider the future cash flows of your business.
2. Profit multiples: The usual measurements are earnings before interest, depreciation, and amortization (EBITDA). The problem here is that for venture capital investors to invest in startups, EBITDA is considered to be highly speculative.
3. Discounted cash flow: This method uses your projections for future cash flow and discounts them using interest rates to produce a value.

•  How Much Funding Do You Need?

It’s a rookie mistake to overestimate how much you think you need for your capital funds. When venture capitalists invest in startups, they like to know what the costs of the business are currently and how they would look down the line. There are three ways to figure out how much to raise:

1. How much capital do you need exactly
2. Current stage of your business’s life cycle
3. Valuation and dilution preference

Remember, the more you ask, the more equity give away.

• Perfect That Pitch:

Generally, most companies are expected to have a business plan, pitch deck, and product demonstration. Having thorough product documentation and references would also be helpful.

1. Your Business Plan:

Don’t make it too lengthy. Use a software tool online to make one which would simplify the entire process. Keep in mind that investors look through hundreds of business plans, so making yours stand out by being relevant and concise, is a smart thing to do. Use graphs and charts when needed to convey information more precisely.

• Your Pitch Deck:

Rather than have a one-for-all pitch deck, make tailor-made ones for each investor meeting you attend. Why? This will help keep the pitch deck pertinent and persuasive to those you intend to show it to. It should include:

• What problem you’re trying to solve
• How you intend to solve that problem
• What are the market conditions you currently face
• What is the product or service you’re trying to sell
• The consumer demand for your product
• Your team and its achievements
• Your competition
• Forecast of your financials
• How much money you intend to raise

• Demonstrate Your Product:

Yes! Just like in Shark Tank! An actual working product can do wonders with your pitch simply because seeing it in person humanizes what you’re trying to sell. It puts a face to your solution and demonstrating it will do you a world of good.

• Product Documentation:

This includes manufacturing, operations, customer service, and merchandise support processes.

• References:

Don’t disregard this. Before pouring money into your business, a venture capitalist’s due diligence would include ringing up your references and asking them several questions. Your references can include recommendations for senior management and customer prospects.

• Have a List of Venture Capital Investors:

Why? Having investors you pitch to that are in the same industry as you can provide enormous benefits down the line. They understand the challenges you’re facing, sympathise with what you lack, and understand what you need.

• Negotiation:

Be careful, and don’t ask for too much. However don’t let this stop you from sacrificing what you can sacrifice, and end up getting what you actually need to get. Don’t be under too much pressure to close a deal. Remember; you can always reconsider and get back at a later time. The things that you might negotiate on are:

1. Pre-money and Post-money valuation
2. Investment type: More often than not, these are convertible preferred stocks.
3. Stock option pools: They are rights given to the holders to buy shares at a predetermined price.
4. Liquidation preferences
5. Board seating rights
6. Expenses – the expenses incurred by a VC are usually expected to be reimbursed by the business and can include legal, consultation, and travel.

• Due Diligence:

These are usually very long, arduous and tiresome. This is the period where you’re cross-checked with all the data that you provided. Be compliant, and proactive, and ask questions during the entire period in case you get stuck anywhere. The more you’re prepared, the faster this process is.

• Wrapping the deal up:

This includes a lot of important paperwork so carefully focus and know what you’re signing on. Some of these documents include:

1. Investment agreements
2. Amendments to the bylaws
3. Voting agreements
4. Certificate of incorporations
5. Stock purchase agreement

VC in a Nutshell

Is it for me? Drawing up your pros and cons list

Now that you’re equipped with everything you need to know, it’s come to the point for you to make your decision. Although the prospect of getting VC funding is exciting, deciding to give away a piece of your business will be a tough choice. There is one last tool though, that can spur you on to make that big decision.

Back in the summer of 1772, Benjamin Franklin, one of America’s most influential freedom fighters, received a letter from his friend, Joseph Priestley, a British scientist. Priestley was torn between making a decision to switch jobs and turned to Franklin for advice. Rather than just give advice, Franklin helped him with a tool which served him for life. A pros and cons list.

Your Pros And Cons List:

Having a summary of all things good and all things bad about VC funding can help push you into making a decision. Although the sample below is generic and does not cover all the facts about making your decision, it would serve as a useful reminder of what you’re about to gain and lose.

Again, this is not the end-all-be-all list, so make one that works for you. Yes, giving away a part of your business will feel brutal, but remember that all the best entrepreneurs in the world have had to do it at some point. Rather than focus on what you’re losing, concentrate on what you’re getting and the countless opportunities you now have at your disposal. Be the firm that you set out to be. Marquee Equity does this better than anyone else out there by providing tailor-made solutions for your specific needs. Solve your problems and get ahead right now – call +1-213-600-7272 to schedule a call with one of our experts!